While MNC stocks have traditionally enjoyed premium valuations, the last 3 years have seen this space underperform. With returns of just 2.6% annualized over the last 3 years, the Nifty MNC TRI index underperformed the Nifty 50 TRI return of 6.8% and even the Nifty 500 TRI return of 3.9%.
It is not just the stock returns. If we take the overall universe of about 118 stocks with over 50% foreign promoter holding (as of September 2020), the average year-on-year profit decline in the past 3 years is in double digits (even if we eliminate Vodafone Idea). Whereas, the average year-on-year profit growth was a flat 1% for the Nifty 500 (without Vodafone Idea) over the same period.
But then, MNC stocks were seldom valued just for their earnings potential. A report by Ambit Capital about 5 years ago, said that growth apart, MNC stocks also received their high valuations from ‘scarcity premium’ coming from high promoter holding and lower free float, and ‘safety trade’ – which included strong technological support from parent, sound cash generation and superior allocation. This aside, buyback stories in MNCs also lend themselves to high valuations. The report went on to say that such high valuation though will become unjustified in the next few years as many an MNC growth story may happen through the unlisted subsidiary space.
This forecast has partly played out as seen by the underperformance in this space. But then, what if there are still stocks that are worth a look –for high balance sheet strength and lower valuation than their earlier averages?
In this second of our screener-based report series (read the first one on COVID-19-resistant companies here), we will try to filter MNC company stocks that stand tall on quality metrics, have high payouts and lower valuations than before. Growth, if any, would be a bonus.
Eliminating low ROE
One of the key characteristics of MNCs is their high return on equity. This is partly to do with their strong initial parent capitalization, low debt, companies at a more mature stage of growth (especially in FMCG and pharma) where additional capital deployment is low and high cash doled out as dividends.
The Nifty 500 companies (as of March 2020) had an average ROE of 13% in the last 3 years. We took 10% as a ROE cut-off for MNC companies as FY-20 did see ROE cuts across the board due to earnings contraction.
What did this simple ROE filter throw up?
- A universe of 67 stocks with ROE greater than 10%. Please download our excel sheet and see the worksheet titled “MNC ROE>10%”
- This universe on an average expanded its ROE from 20% in FY-18 to 25% in FY-20.
- 37 stocks of the 67 saw an expansion in ROE between FY18-20.
- 59 of the 67 companies in this universe had a positive operating cash flow for each of the last 3 years from FY18-20.
- The average year-on-year sales growth (that is, sales growth for each of the past 3 years) was flat while earnings growth was a healthy 9% average. Compare this with the overall MNC universe which saw a double-digit fall, like we mentioned earlier. Clearly, eliminating poor ROE companies ensured you were left with players with better earnings growth.
- 33 of the 67 companies had dividend payout of above 30% for the past 3 years. The Nifty 50 companies had a dividend payout of 30% in the latest ended fiscal.
- 4 in 10 companies in this universe also saw mutual funds increasing their stakes in these companies in the past 3 quarters from March 2020 to September 2020.
- 34 of these 67 companies saw their price to book ratio (PB) trading below their 3-year averages and 25 of them have their price to earnings (PE) lower than their 3-year averages.
Now that is a lot of data! In our earlier screener report, some of you asked us if this is yet another analysis story. Our response is a ‘yes’ and ‘no’. The idea of this is to give you cues on the kind of screeners you could be using to filter stocks. Using the right metrics based on the nature of the universe can sometimes help unearth stocks that you may otherwise miss.
In our universe, we knew that MNC stocks were underperforming. But the moment we used MNC stocks’ biggest strength – their ROE – as a filter, we automatically saw the quality and growth metrics dramatically change. Now this is what you will learn to do on reading these filter stories. As for the filters themselves, you will be able to use our own equity tool to do this, when our product is out.
MNC Stocks – narrowing the universe
Let us now get into how you can narrow this universe of 67 with relevant filters. We started with companies that had ROE of over 10% on an average in the past 3 years. Expansion in ROEs would be a good improvisation. This is important as the Nifty 500 itself saw ROEs contract from an average 15.6% in FY-18 to to 13.4% in FY-20. So, let’s look for those MNCs that bucked this trend.
#1 Expanding ROEs
When we look for MNCs that expanded their ROEs between their latest balance sheet and 2 years ago, the 67 list narrows to 37 stocks. This 37-stock list is not just about your usual suspects of Nestle India or Hindustan Unilever or the more recent favourite Abbott India. It has tiny caps such Rama Phosphates, Voith Paper Fabrics to small caps such as Disa India and John Cockrill India from the capital goods space.
Barring just 1 company (Inspirisys Solutions Ltd) that saw a decline in profits year-or-year between FY18-20 and Procter & Gamble Hygiene & Health Care whose profits remained flat in the said period (although expanding between FY-19 and FY-20), all other companies saw earnings growth. In other words, quality companies also saw growth.
Please see the worksheet named “expanding ROEs” in the excel sheet.
#2 High dividend payout
Next, we checked for companies with high dividend payouts (dividend as a proportion of earnings). Even if a stock does not deliver stellar returns in price, regular dividend payouts can significantly improve your total return on the stock. This is something that you tend to neglect as it comes to you as a cash flow. Note that this is different from ‘dividend yield’ which is a valuation metric. You might want to read more about cash returned to shareholders and its importance here.
For this purpose, we took the Nifty 50 stocks’ average pay-out of 30% for FY-20 as a cut-off. We decided to see the average payout for the past 3 years to ensure that such payouts are sustainable (you may still have a company or 2 with very high payout in just 1 year. You can check the data we have to eliminate them).
Our 37-stock list reduced to 18 stocks. You can check the excel sheet for the worksheet called dividend payout. The stocks are also listed below.
Do it yourself now
Now, at this stage, there are multiple things you can do:
- Look at the fundamentals of these high dividend payout companies, including some of the metrics such as operating cash flow to EBIDTA that we have provided in the excel. (note that operating cash flow or any ratio based on that will not be relevant for finance companies).
- Look for stocks that are trading below their average 3-year price to book ratio or price to earnings ratio from this list of 18 stocks or even from the list of 37 stocks. We have already provided these criteria. You can simply use the excel filter to look stocks that are ‘lower’ than their 3-year average valuations.
- Look for stocks that have seen an increase in mutual fund holding. We have provided this in the excel as a column.
Just to give you an illustration, if you are not particularly looking for high dividend payout options, you could revisit the 37-stock expanding ROE list and look at:
- Stocks that are trading at lower price to book value than their 3-year average.
- Companies that are operating cash flow positive for past 3 years
- Stocks with stable holding or increase in holding by mutual funds
We took the price to book instead of price to earnings given that PE is seldom a good indicator for the high premium that the market affords to this MNC stocks space.
You will end with this result below. Do check the excel sheet for more details of the various metrics and how you could possibly slice and dice them. This will help narrow your companies to just a handful to do your deep dive. And while you are at it, do check the volumes traded in these stocks as many MNC stocks tend to have very low float.
So, what did we exactly do in this filter? We took a universe that has been underperforming for 3 years to see if these companies have shown resilience and strength in some form or whether they are at least returning the cash if they are unable to grow. Such an approach will be needed when you are analysing companies in a downturn.
With inputs from Anush Raj P
Note: This article on MNC stocks is only based on simple screeners to provide you with some cues on how to use screeners. They are not stock recommendations. As an investor, you need to do your due diligence before deciding to invest in any of them.